Question
Halloween Industries Co. (HIC) is contemplating issuing a 30-year bond with a coupon rate of 6.33% (with annual coupon payments) and a face value of
Halloween Industries Co. (HIC) is contemplating issuing a 30-year bond with a coupon rate of 6.33% (with annual coupon payments) and a face value of $1,000. HIC believes it can get a rating of A from Standard and Poor's. However, due to recent financial difficulties at the company, Standard and Poor's is warning that it may downgrade Halloween Industries bonds to BBB. Yields on A-rated long-term bonds are currently 5.83%, and yields on BBB-rated bonds are 6.23%. Keep in mind, as you calculate the following prices, that if an exisitng bond with a given amount of risk [as proxied for by a bond rating] offers a yield to maturity of, say, 5.83%, bondholders evaluation the investment-worthiness of a new bond with the same risk will require the same 5.83% return on the new bond.
a. What is the price of the bond if HIC maintains the A rating for the bond issue?
b. What will the price of the bond be if it is downgraded?
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